56
Responding to a Shadow Banking Crisis: the Lessons of 1763 Stephen Quinn, TCU William Roberds, FRB Atlanta Presented in Honor of Warren Weber February 18, 2012
Responding to a Shadow Banking Crisis: the Lessons of 1763
Stephen Quinn, TCU
William Roberds, FRB Atlanta
Presented in Honor of Warren Weber
February 18, 2012
Motivation
To better identify
the persistent properties
of shadow bank instability
Method
To reconstruct a historical episode
that is similar to,
but not identical to the recent crisis.
Similarities
1763 2007-8
Securitization Bill of exchange Many (ABCP)
Shocking failure Neufville Lehman
Rollover crisis? Yes Yes
Central bank Bank of Amsterdam Federal Reserve
CB Lender to guarantors? Yes Yes
CB Emergency facilities? Bullion Numerous
Differences
1763
2007-8
Regulation
Settlement Prudential
Bailouts
None Too big to fail
International liquidity
None Currency swaps
Open Market Operations None Quantitative Easing
Outline
1. Shadow Banking 2. Data 3. Shock 4. Run and Response
Table 1: stylized ABCP conduit
Period 0: (a) D creates and sells an ASSET to B (b) B creates and sells ABCP1 to C1
Period 1: (a) B creates and sells ABCP2 to C2 (b) B repays C1 for ABCP1
Period 2: (a) D repays B for ASSET (b) B repays C2 for APCP2
Shadow Run
Period 0: (a) D creates and sells an ASSET to B (b) B creates and sells ABCP1 to C1
Period 1: (a) B creates and sells ABCP2 to C2 (b) B repays C1 for ABCP1
Period 2: (a) D repays B for ASSET (b) B repays C2 for APCP2
Table 2: stylized acceptance loan, 1763
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1
Table 2: stylized acceptance loan, 1763
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Table 2: stylized acceptance loan, 1763
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1
Table 2: stylized acceptance loan, 1763
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2
Table 2: stylized acceptance loan, 1763
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg
Period 2: (a) D accepts BILL2
(b) B settles BILL1 with C1
Period 3: (a) D settles BILL2 with C2
Numerical Example Period 0
• C1 gives 100 Hamburg thalers for BILL1. • BILL1 obliges B to pay 165 bank guilders in two months at the
Bank of Amsterdam. The exchange rate is 1.65:1.
Period 1
• B sells BILL2 to C2 for 166 bank guilders. 165 will settle BILL1 and 1 is a service fee.
• BILL2 obliges D to pay 101.8 thalers in Hamburg in two months. The exchange rate is 1.63:1.
Period 3
• D pays an annualized 4-month rate of 5.4 percent
Phase 1: Rollover Crisis
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg
Period 2: (a) D accepts BILL2
(b) B settles BILL1 with C1
Period 3: (a) D settles BILL2 with C2
Phase 2: Acceptance Collapse
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg
Period 2: (a) D accepts BILL2
(b) B settles BILL1 with C1
Period 3: (a) D settles BILL2 with C2
Phase 3: Securitization Collapse
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg
Period 2: (a) D accepts BILL2
(b) B settles BILL1 with C1
Period 3: (a) D settles BILL2 with C2
Outline
1. Shadow Banking 2. Data 3. Shock 4. Run and Response
Recorded at the Bank of Amsterdam?
In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B
(b) D sells it to C1 C1 travels to Amsterdam
Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg
Period 2: (a) D accepts BILL2
(b) B settles BILL1 with C1
Period 3: (a) D settles BILL2 with C2
Bank of Amsterdam Balance Sheet August 1, 1763, in bank guilders
Assets Liabilities Metal 21,895,124 Accounts 22,660,145 Under Receipt (“Repo”)
21,606,690 Unencumbered
288,434
Loans 527,264 Capital -237,757 Total 22,422,388 Total 22,422,388
Data for 1763
• Weekly gross payments between
o each of the 8 largest merchant bankers
o each banker with the rest of the Bank of Amsterdam
o each with the Bank of Amsterdam’s master account
• Week-start balances of the same.
Data Shows
• New bills financed acceptances before the crisis.
Table 3. Bank of Amsterdam transactions, January-July 1763 Weekly Means in Thousands of Bank Guilders
Merchant bank Starting balance Total
Payments Payments/ Balance
Hope & Compagnie 439.3 473.9 1.12 Andries Pels & Zoonen 359.7 245.8 0.70 George Clifford & Zoonen 277.1 392.3 1.49 Gebroeders de Neufville 103.3 241.3 2.69 Vernede & Compagnie 99.0 179.5 2.75 Raymond & Theodoor de Smeth 77.7 164.5 2.57 Horneca Hogguer & Co. 69.7 146.7 2.51 Charles & Theophilus Cazenove 68.7 227.7 4.25
Total 8 large banks 1,494.5 2071.7
(Rest of the Bank accounts) 21,686.0 1925.31 1 Sum of coin withdrawals plus transfers to eight most active accounts.
Data Shows
• New bills financed acceptances before the crisis.
• The failure of Neufville caused a sudden drop in bill
creation.
• Liquidity creation prevented additional failures.
Outline
1. Shadow Banking 2. Data 3. Shock 4. Run and Response
May 1763
1. decline in commodity prices. 2. demonetization of Prussian coins.
Debtors suddenly lacked means to pay bills.
May 1763
1. decline in commodity prices. 2. demonetization of Prussian coins.
Debtors suddenly lacked means to pay bills.
So debtors draw and sell new bills on Amsterdam. Silver bullion follows in hopes of paying the new bills.
Lehman Moment Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders.
Lehman Moment Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders. Neufville’s total assets? 10 million guilders.
Lehman Moment
Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders. Neufville’s total assets? 10 million guilders. Neufville’s average weekly funding requirement? 241,000 guilders.
Lehman Moment Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders. Neufville’s total assets? 10 million guilders. Neufville’s average weekly funding requirement? 241,000 guilders. Neufville suspends payments on July 30.
Too Big to Fail?
This morning … we received a fatal express, with the terrible news that you, the gentlemen of Amsterdam, would leave the Neufvilles to sink, by which we were all thunderstruck; never dreaming that so many men in their senses in your city could take such a step … which will infallibly plunge all Europe in an abyss of distress, if not remedied by you whilst it is still time.
--- Petition from Hamburg, August 4, 1673
From Tooke (1838, 149-150).
Consequences of Neufville Failure
Direct
Consequences of Neufville Failure
Direct
Indirect
Scramble for coin Run on deposit banks
Rollover crisis
Rollover Crisis Payments value by source, 1763:1-1764:1
3-week moving averages. Source: Stadsarchief Amsterdam 5077.
Mill
ions
Ban
k Fl
orin
s
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan1763
0.0
0.5
1.0
1.5
2.0
2.5LARGEST_BANKS
PARVENUS
ROB
Metal inf lows
Outline
1. Shadow Banking 2. Data 3. Shock 4. Run and Response
Run and Response Weekly position of Horneca Hogguer
-300-200-100
0100200300400
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64
Tho
usan
ds o
f Ban
k G
uild
ers
Balances CUM Transfers CUM Coin
Run and Response Weekly position of Hope
0
200
400
600
800
1,00025
-Jul
-63
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64
Tho
usan
ds o
f Ban
k G
uild
ers
Balances CUM Transfers CUM Coin
Additional Response
• Open Market Operations? • Ad hoc bullion repo window
o unlimited amounts o low interest rate o large haircut
Run and Response Weekly position of Cazenove
-1,000-800-600-400-200
0200400600
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64
Tho
usan
ds o
f Ban
k G
uild
ers
Balances CUM Transfers CUM Coin CUM Bullion
Run and Response
Weekly position of Smeth
-150-100-50
050
100150200250
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64T
hous
ands
of B
ank
Gui
lder
s
Balances CUM Transfers CUM Coin CUM Bullion
Non-Bank Response
Weekly cumulative positions for the rest of the Bank
0123456
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64M
illio
ns o
f Ban
k G
uild
ers
CUM Coin CUM Bullion
Lessons
1763 confirms that a shadow run is a rollover crisis.
Lessons
1763 confirms that a shadow run is a rollover crisis.
1763 suggests that a smaller scale of central bank response
can be sufficient for local effectiveness.
Weekly Central Bank Assets in 1763 and 2008
Sources: Federal Reserve and Stadsarchief Amsterdam 5077
0.50
1.00
1.50
2.00
2.50
3.00
0.50
1.00
1.50
2.00
2.50
3.00
-26 -23 -20 -17 -14 -11 -8 -5 -2 1 4 7 10 13 16 19 22
Ass
ets S
cale
d to
Wee
k 0
Weeks Before and After Major Failure0=1 August, 1763 and 0=10 September, 2008
AMS: Traditional
FED: Traditional
Weekly Central Bank Assets in 1763 and 2008
Sources: Federal Reserve and Stadsarchief Amsterdam 5077
0.50
1.00
1.50
2.00
2.50
3.00
0.50
1.00
1.50
2.00
2.50
3.00
-26 -23 -20 -17 -14 -11 -8 -5 -2 1 4 7 10 13 16 19 22
Ass
ets S
cale
d to
Wee
k 0
Weeks Before and After Major Failure0=1 August, 1763 and 0=10 September, 2008
AMS: Bullion Window
AMS: Traditional
FED: Lending to Non-Bank CreditMarkets
FED: Traditional
Weekly Central Bank Assets in 1763 and 2008
Sources: Federal Reserve and Stadsarchief Amsterdam 5077
0.50
1.00
1.50
2.00
2.50
3.00
0.50
1.00
1.50
2.00
2.50
3.00
-26 -23 -20 -17 -14 -11 -8 -5 -2 1 4 7 10 13 16 19 22
Ass
ets S
cale
d to
Wee
k 0
Weeks Before and After Major Failure0=1 August, 1763 and 0=10 September, 2008
AMS: Bullion Window
AMS: Traditional
FED: Central Bank Swaps, AgencyDebt & MBS, AIG Rescue
FED: Lending to Non-Bank CreditMarkets
FED: Traditional
Questions?
Weekly “funding gap” with non-banks
-1-0.5
00.5
11.5
22.5
3
28-J
an
21-F
eb
21-M
ar
18-A
pr
16-M
ay
13-J
un
11-J
ul
8-A
ug
5-Se
p
3-O
ct
31-O
ct
28-N
ov
26-D
ec
Mill
ions
of B
ank
Gui
lder
s
Net Flow Payments from Others to BanksPayments from Banks to Others
Figure 10: Simulated balances with no bullion window + 2 failures
Horneca, July 1763-January 1764
Thou
sand
s B
ank
Flor
ins
August September October November December-100
-50
0
50
100
150
200
250
300
HornecaScenario
Hope, July 1763-January 1764
Thou
sand
s B
ank
Flor
ins
August September October November December300
400
500
600
700
800
900
1000
HopeScenario
-2,000-1,500-1,000
-5000
5001,0001,5002,0002,500
Tho
usan
ds o
f Ban
k G
uild
ers
Figure
0000000000
24-J
an-6
3
21-F
eb-6
3
Balance
6: Wee
with a
21-M
ar-6
3
18A
63
es CU
ekly tota
accumu
18-A
pr-6
3
16-M
ay-6
3
UM Transfe
al banke
ulation b
13-J
un-6
3
11-J
ul-6
3
ers CU
er balan
by chan
8-A
ug-6
3
5-Se
p-63
UM Coin
nces in 1
nnel
5Se
p63
3-O
ct-6
3
CUM
1763
31-O
ct-6
3
28-N
ov-6
3
M Bullion
26-D
ec-6
3
Figure C3. Weekly balances of Pels
-200
0
200
400
600
800
1,000
1,200
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64
Tho
usan
ds o
f Ban
k G
uild
ers
Balances CUM Transfers CUM Coin CUM Bullion
Figure C4. Weekly balances of Clifford
-600
-400
-200
0
200
400
600
800
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64
Tho
usan
ds o
f Ban
k G
uild
ers
Balances CUM Transfers CUM Coin CUM Bullion
Figure C6. Weekly balances of Vernede
-250-200-150-100-50
050
100150200250300
25-J
ul-6
3
8-A
ug-6
3
22-A
ug-6
3
5-Se
p-63
19-S
ep-6
3
3-O
ct-6
3
17-O
ct-6
3
31-O
ct-6
3
14-N
ov-6
3
28-N
ov-6
3
12-D
ec-6
3
26-D
ec-6
3
9-Ja
n-64
Tho
usan
ds o
f Ban
k G
uild
ers
Balances CUM Transfers CUM Coin CUM Bullion
S
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